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What Is Credit?

Credit refers to you having the ability to borrow money, goods, or services that you would have to pay back at a later date. Lenders and creditors will grant it based on your credit history and the confidence they have in your ability to repay whatever you choose to borrow.

As you begin to pay off your debts on time creditors will start to see you as being creditworthy. This is why it’s so important to focus on paying all your bills on time and meet all of your financial obligations. 

How Does Credit Work?

Your credit will continue to build over time as you continue to borrow money and pay it back on time. If lenders see you have a low score they will have less confidence that you will be able to repay them, so you may have difficulty getting approved for a loan. Lenders will use your score to determine whether or not to issue you credit. 

What Is Credit In Simple Words?

In simple words it refers to a three-digit number which is based on information from your credit reports. This will help you get approved for loans that you may need in the future. 

What Is Credit Used For?

It is a part of your financial power and it’s used to help you receive the things you need now. Having a low score can prevent you from obtaining auto loans, personal loans, or even student loans.

It also can be used to help you buy insurance coverage which is important if you ever face a financial crisis due to unemployment, or a possible disability. Some employers will even look at your credit history before they hire you for a job. They want to ensure that you are responsible enough to work for the company. 

What Is an Example of Credit?

An example would be “Bob has $5,000, and Mary is in need of a loan. Bob is a creditor and chooses to loan Mary $3,000, but Mary can’t pay it back straight away. So Bob lets Mary have the $3,000 on credit and adds a 2.0% interest rate to ensure that he can make money off this investment over time.”. So now Mary has the money she needs and has a $3,000 debt to Bob plus interest.

Types of Credit

The 3 main types include installment, revolving and open credit. They are based on the various term lengths, the payment type, and the monthly amount due.

Revolving

Revolving requires borrowers to pay a minimum amount of their balance each month which will then be rolled-over with added interest charges at the same time each month. Each payment will replenish the account holder’s available funds, minus the interest and fees paid.

Installment

Installment requires that you pay a fixed sum each month which is based on when you are borrowing money, the agreed-upon interest rate, and the total amount you choose to borrow. The interest rate, maturity term, and payments on the loan will all affect how much will owe each month

Open

A pre-approved loan between a borrower and a lender would be referred to as open credit. It permits the creditor to make several deposits up to a certain amount before making future repayments when the payments are due.

Secured

Secured credit is backed by an asset, a home, or other property. With secured credit, you often need to pledge something of value as collateral in order to secure a loan. If you do not pay back the loan creditors may be able to gain possession of your belongings that you are using as collateral to obtain the loan.

Unsecured

Unsecured credit would be something that is not backed by an asset. When obtaining unsecured credit it’s important to have a good credit history. If you don’t have that then you will more than likely will have to pay back a loan with a high-interest rate.

Good vs Bad Credit

Having good or bad credit can affect so many different aspects of your life. Credit can affect your ability to get a loan. In addition, your score will impact the interest rates percentages that will be added to your loan. 

Benefits of Good Credit

  • Lenders Will Have More Trust in You: This provides you the ability to repay them. You will be more likely to be approved for a new loan. It also will influence the interest rates and fees that will be added to your loan.
  • Landlords Are More Likely to Rent to You: Potential landlords will want to rent out their property to someone they can trust to pay their rent on time every month. Landlords will be to check your credit history, which will play a part of their decision making process.
  • Better Student Loan Eligibility: It can even help you receive a student loan. This is of course if you decide you would like to go back to school someday. Your student loan eligibility will be negatively affected and you may not be able to finance your education. 

Disadvantages of Bad Credit

  • Higher Interest Rates: Creditors are more likely to give you high-interest rates. This is because they will see you as a risky borrower. You’ll also pay a lot more interest that will grow quickly over time. 
  • You May Have to Pay Security Deposits Upfront: Utility and electric companies check credit scores during the application process. If you have poor credit they may want to charge you before they allow you to establish service under your name for their company. 

Getting Help Building Credit  

Working to build credit and paying off any creditors that you receive loans from is essential to your family’s financial security. Financial advisors can build you an effective financial investment strategy to help you pay off your debt.

A financial advisor will provide you with a debt repayment plan that will improve your score in no time. It’s important to understand your financial standing so that you can save and invest for the future. You should take a look at our guide on how to choose a financial advisor